The markets were relatively calm overnight. Not much action in any direction.
The day-to-day humdrum continues…for now.
There’ll be plenty of action in the markets to talk about in the coming months, but, today, let’s look at the vexing issue of retirement. More specifically, let’s run through the ‘who’ and ‘how’ of retirement.
Once upon a time, retirement was a shimmering oasis on the horizon. After decades in the workforce, you would be rewarded with paradise — the freedom to do what you want to do…when you want to do it. No more nine-to-five (or, if you’re self-employed, five-to-nine). Sleep in, play golf, travel, and enjoy a long lunch without having to watch the clock.
The grass certainly looks greener on the other side of 65. Until you get there.
Low interest rates. Harsher asset tests. Nervousness over which will expire first: you or your capital…
These issues impact the majority of retirees…some more consciously than others.
The Australian Government’s National Commission of Audit forecasts that 80% of Australians will be dependent on either a full or part pension for decades to come.
Source: National Commission of Audit
[Click to enlarge]
The social contract between a government and its older citizens — to fully or partly fund a retirement income — is both under review and under pressure.
In recent days, Treasurer Scott Morrison has been warning that either welfare cuts or increased taxes will have to come under consideration. While the proposed welfare cuts do not relate to the age pension, it is part of the conversation the government is having with the public about curbing the growth in welfare spending. It is one or the other…or a combination of both. No more free lunches.
In due course, the focus will shift to the age pension.
As Deputy PM Barnaby Joyce said recently (reported by SBS):
‘…recurring expenditure like social welfare couldn’t be put on the government credit card year in, year out.
‘“The nation can’t do that otherwise your credit card gets bigger and bigger and more and more in debt,” he told reporters in Canberra.
‘“In the end the people who lend you the money for the credit card say ‘that’ll do us.’”’
And there is no bigger recurring expenditure than age pensions…especially with wave after wave of boomers coming through and living longer.
Age pensions are a sacred cow. Changing societal attitudes is not something that’s done overnight.
As part of the softening-up process, the inclusion of the family home in the asset test is again attracting media attention:
‘Make family home part of aged pension means test, says ACCI (Australian Chamber of Commerce and Industry)’ — The Australian, 3 February 2017:
‘Its [ACCI] budget submission says people older than 65 have almost $1 trillion in equity in their homes, which should be used to defray the costs of retirement.
‘It says the value of a home in excess of a threshold of about $450,000 could either be used in the Age Pension means test or to secure an interest-free loan to cover living costs for the first five years after becoming eligible for the pension. The loan would be recouped when the property was sold, either on death of the owners or their shift into aged care.
‘“Paying taxes throughout life does not entitle citizens to a government-funded pension regardless of financial circumstances,” the business group says. “Taxes pay for government services in the year they are collected.”’
There’s more chance of snow on the Gold Coast in December than there is of the family home retaining its current asset test exemption. Plan for it.
Beware of investment-industry solutions to your problem
The other sure bet is the investment industry’s involvement in creating a ‘solution’ to your retirement-income problem.
A bout of severe market volatility will bring forth ads for annuities…it always does.
The ‘opportunity’ for you to receive a guaranteed income — by handing over your money to a company in order to have it paid back to you in regular dribs and drabs — and peace of mind. What happens if the market volatility is so great and sustained that the solvency of the annuity company comes into question? There is then no government guarantee to secure your funds. If the annuity company folds, then, odds are, your money is gone. Don’t believe me? Read the fine print at the back of the Product Disclosure Statements that highlights where the pool of funds is invested and who actually guarantees the funds…you’ll be surprised at what you find.
Once the family home is assessable, banks and other lenders will ramp up reverse mortgage products. There will be plenty of fine-print disclaimers with these products too. No doubt, some very sad stories of people who ‘thought one thing and got something else’ will appear on those wonderfully-informative current affairs-type programs.
The other night, on one of the news channels, there was a segment asking the question: ‘Who needs to be a millionaire to retire?’ Naturally, my professional curiosity was aroused.
According to an Industry Super spokesperson that took part in the program, the average superannuation balance is $160,000. Thoughts of attaining the magical million-dollar retirement goal are, therefore, fanciful for the majority.
How do you make ends meet in retirement on $160,000? It’s simple…or at least that’s what the spokesperson conveyed.
As a homeowner couple, you’ll be eligible for a full age pension of $34,380 (a single person receives $22,800).
Then, according to the spokesperson, your $160,000 will pay you $300 per fortnight to pay for those little extras.
All sounds good. Where do I sign?
But, again, the devil is always in the detail.
Let’s see… $300 per fortnight equates to $7,800 per annum. That’s a 5% return on your $160,000. Last time I looked, a secure investment will pay, at best, 3% per annum. Where do you get 5% from? Well, an account-based pension (which just so happens Industry Super funds provide) must pay — by law — a minimum 5% of the account balance for those aged between 65 and 74.
The fund must pay 5%, regardless of whether it earns its keep or not. If the fund earns 8%, happy days, you have 3% added to your capital. But what happens if the fund earns minus 6.4%?
You are on a slippery slope from which there is no way back.
To illustrate this point, the following is an extract from my latest book, How Much Bull Can Investors Bear?
‘Below is the median annual return for balanced funds over the past seven financial years:
- 2007/2008 financial year: -6.4% (loss)
- 2008/2009 financial year: -12.7% (loss)
- 2009/2010 financial year: 9.8% (gain)
- 2010/2011 financial year: 8.7% (gain)
- 2011/2012 financial year: 0.4% (gain)
- 2012/2013 financial year: 14.7% (gain)
- 2013/2014 financial year: 12.7% (gain)
- 2014/2015 financial year: 9.7% (gain)
‘The table below shows the outcome if we apply the above performance figures to our $500,000 investment — $100,000 in cash (four-year buffer) and $400,000 in balanced fund — and assume a drawdown of $25,000 per annum (not indexed) for living expenses.
(Note the $100,000 cash buffer plus interest earned exhausts the cash buffer after 4.5 years. Therefore, halfway through year five, we need to draw on the balanced fund to pay our retiree their income.)
Year Start Amount of Balanced Fund Performance Balance Less Annual Drawdown End of year balance of Balanced Fund 07/08 $400,000 Minus 6.4% $374,400 Nil $374,400 08/09 $374,400 Minus 12.7% $326,850 Nil $326,850 09/10 $326,850 Plus 9.8% $358,880 Nil $358,880 10/11 $358,880 Plus 8.7% $390,100 Nil $390,100 11/12 $390,100 Plus 0.4% $391,600 $12,500 $379,160 12/13 $379,160 Plus 14.7% $434,900 $25,000 $409,900 13/14 $409,900 Plus 12.7% $461,960 $25,000 $436,960 14/15 $436,960 Plus 9.7% $479,345 $25,000 $454,345
‘After eight years, our starting $500,000 is now worth $454,345 (the cash buffer expired in early 2012).
‘The account balance would be much lower if the drawdown had been indexed (which happens in reality). In addition, if a planner was involved, there would also be establishment and ongoing fees deducted from the account balance. What we see above is a “best case” scenario.
‘The fact is that if your account-based pension (with a focus on growth) gets hit early by negative returns, it’s unlikely you’ll ever recover your starting position.
‘As you can see, the impact of two negative years has not been offset by six positive years. And in the context of negative returns, minus 6.4% and minus 12.7% are not all that catastrophic.’
With the US share market reaching record highs based on nothing more than investors being prepared to apply an ever-higher multiple to earnings, another negative year (or two or three) is all but certain for the future.
If you have $160,000, or even $500,000, do you need to be in an account-based pension?
The industry will say ‘the income stream is tax free.’ True.
But, for a lot of retirees, so are earnings from a term deposit in your own name.
Have I got your interest (pardon the pun) now?
Under the Seniors and Pensioners Tax Offset (SAPTO) rules, there are very generous tax-free thresholds for people eligible to receive a pension.
[Click to open in a new window]
A couple can earn $57,948 before paying a cent in tax.
That’s an additional $23,000 in other income above the full age pension.
The investment industry won’t tell you this because it means you do not need the products they sell.
In my opinion, with the fragile state of markets, the retiree couple with $160,000 would be better off putting their money in a term deposit earning 3% tax-free, rather than exposing their capital to the slippery slope of negative returns…and incurring unnecessary product and planner fees.
Simple and uncomplicated. But, more importantly, government guaranteed…
I genuinely feel sorry for retirees and pending retirees. There are enormous changes coming. The idyllic lifestyle they spent their working years looking forward to is going to be far more challenging than they had imagined.
The investment industry’s self-interest in promoting products that may not be entirely in a retiree’s best interests is only going to add to the confusion.
While you may not need to be a millionaire to retire, you will need to be on your toes to ensure you don’t become an unwitting contributor to the millions of dollars being made by the product-makers who capitalise on the confusion that change inevitably brings.
Editor, Markets and Money